Exponential Functions

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Exponential functions are

functions with x as the input
variable, and x is in the
position of an exponent to a
base. That is, these functions,
in simple form, look like this:

f(x) = 3x
The following links explain
several aspects of
exponential functions.

Definition
Transformations of f(x) = 2x
Exponential Growth
Radioactive Decay
Money Matters
Simple Interest
Compound Interest
Continuous Interest
Effective Annual Rate
Ordinary Annuity
Loans
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Simple Interest
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Explanation
Simple interest is earned on the principal only.

Simple interest is not an example of an exponential function. Understanding simple

interest, though, will shed light on the understanding of compound interest which is an
example of an exponential function.

Formula

T Final value of investment

P Initial value of investment
Number of interest periods,
n
usually number of years
Percentage rate per interest period,
r
if per year, the annual percentage rate or APR

At start:

T=P

After 1 period:

T = P + Pr = P(1 + 1r)
After 2 periods:

T = P + Pr + Pr = P + 2Pr = P(1 + 2r)

After 3 periods:

T = P + Pr + Pr + Pr = P + 3Pr = P(1 + 3r)

After n periods:

T = P(1 + nr)

Example calculation
If $200 dollars is invested and earns 8.0% simple interest, what is the final value of
the investment after 6 years?

T = P(1 + nr)

T = 200(1 + (6)(0.080))

T = $296

Calculator for simple interest

T = P(1 + nr)

T Final value of investment

P Initial value of investment
Number of interest periods,
n
usually number of years
Percentage rate per interest period,
r
if per year, the annual percentage rate (APR)

Enter values for the above formula:

(Example: For r enter 5.0% as 0.05, etc.)

P: n: r:

After entering values into the above input areas, click the following 'Calculate' button
to get T, the final value of the investment.

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Compound Interest
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Explanation
Compound interest is paid both on the original principal and on the accumulated past
interest.

Formula

S Final value of investment

P Initial value of investment
i Interest rate per period
n Number of interest periods

At start:

S=P

After 1 period:

S = P + Pr = P(1 + i)

Amount at the start of this period

Amount of interest earned during this period on the starting amount of this period
Final value at end of this period

After 2 periods:

S = P(1 + i) + P(1 + i)i = P(1 + i)(1 + i) = P(1 + i)2

Amount at the start of this period, i.e., the final value at the end of the last period

Amount of interest earned during this period on the starting amount of this period

Final value at end of this period

After 3 periods:

S = P(1 + i)2 + P(1 + i)2i = P(1 + i)2(1 + i) = P(1 + i)3

Amount at the start of this period, i.e., the final value at the end of the last period

Amount of interest earned during this period on the starting amount of this period

Final value at end of this period

After n periods:

S = P(1 + i)n

Often the interest per period, i, is expressed in terms of the annual percentage rate
(APR), r, and the number of interest periods per year, k.

Under these conditions the interest per period is equal to the annual percentage rate
divided by the number of interest periods per year, as in:

i=r/k

This would make the above formula for the final value of an investment after n
interest periods look like this:

S = P(1 + r/k)n

Notice that the output, S, is an exponential function of n. That is, if we consider the
final value of the investment as a function of the length of time for the investment,
then n, the length of time for the investment, is in the exponent position, and this
makes S an exponential function of n.
Example calculation
If $4000 is invested at an annual rate of 6.0% compounded monthly, what will be the
final value of the investment after 10 years?

Since the interest is compounded monthly, there are 12 periods per year, so, k = 12.

Since the investment is for 10 years, or 120 months, there are 120 investment periods,
so, n = 120.

S = P(1 + r/k)n

S = 4000(1 + 0.06/12)120

S = 4000(1.005)120

S = 4000(1.819396734)

S = $7277.59

Calculator for compound interest

S = P(1 + r/k)n

S Final value of investment

P Initial value of investment
r Annual percentage rate (APR)
k Interest periods per year
r/k Percentage rate per interest period
n Number of interest periods

Enter values for the above formula:

(Example: For r enter 5.0% as 0.05, etc.)

P: r: k: n:
After entering values into the above input areas, click the following 'Calculate' button
to get S, the final value of the investment.

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Continuous Interest
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Explanation
Continuous interest is a form of compound interest. With continuous interest the
length of the compounding period is reasoned to be infinitely small. The interest,
therefore, is compounded continuously.

Formula

S Final value of investment

P Initial value of investment
r Annual percentage rate (APR)
t Number of years

Value of investment after t years:

S = Pert

Where e is the transcendental number 2.7182818285...

Notice that the output, S, is an exponential function of t. That is, if we consider the
final value of the investment as a function of the length of time for the investment,
then t, the length of time for the investment, is in the exponent position, and this
makes S an exponential function of t.
Example calculation
If $4000 is invested at an annual rate of 6.0% compounded continuously, what will be
the final value of the investment after 10 years?

S = Pert

S = 4000e(0.06)(10)

S = 4000e0.6

S = 4000(1.822188)

S = $7288.48

Calculator for continuous interest:

S = Pert

S Final value of investment

P Initial value of investment
r APR, Annual percentage rate
t Number of years

Enter values for the above formula:

(Example: For r enter 5.0% as 0.05, etc.)

P: r: t:

After entering values into the above input areas, click the following 'Calculate' button
to get S, the final value of the investment.

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 Effective Annual Rate
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Explanation
The effective annual rate is a value used to compare different interest plans. If two
plans were being compared, the interest plan with the higher effective annual rate
would be considered the better plan. The interest plan with the higher effective annual
rate would be the better earning plan.

For every compounding interest plan there is an effective annual rate. This effective
annual rate is an imagined rate of simple interest that would yield the same final value
as the compounding plan over one year.

Formula

S Final value of investment

P Initial value of investment
ieff Effective annual rate
r Annual percentage rate (APR)
k Interest periods per year

After a term of one year the final value, S, of a compounded interest investment with
an initial value P compounded k times per year at an annual percentage rate of r is
given by:

S = P(1 + r/k)k

After a term of one year the final value, S, of a simple interest investment with an
initial value P at an annual percentage rate of ieff is given by:

S = P(1 + ieff)

Setting these two equal we get:

P(1 + ieff) = P(1 + r/k)k

Dividing each side by P we get:

(1 + ieff) = (1 + r/k)k

And solving for ieff we get:

ieff = (1 + r/k)k - 1

Example calculation
Which plan is the better investment plan?

Plan 1:

8.0% annual percentage rate, compounded monthly

Plan 2:

7.9% annual percentage rate, compounded daily

ieff for plan 1:

ieff = (1 + r/k)k - 1

ieff = (1 + 0.08/12)12 - 1

ieff = (1.006666666)12 - 1

ieff = (1.082999498) - 1

ieff = 0.082999498

ieff = 8.2999%
ieff for plan 2:

ieff = (1 + r/k)k - 1

ieff = (1 + 0.079/365)365 - 1

ieff = (1.000216438)365 - 1

ieff = (1.082194930) - 1

ieff = 0.082194930

ieff = 8.2194%

Plan 1 is better since 8.2999% > 8.2194%

Calculator for effective annual rate:

ieff = (1 + r/k)k - 1

ieff Effective annual rate

r APR, Annual percentage rate
k Times per year compounded

Enter values for the above formula:

(Example: For r enter 5.0% as 0.05, etc.)

First Plan
r: k:
Second Plan
r: k:
After entering values into the above input areas, click the following 'Calculate' button
to get ieff, the effective annual rate, for both plans.

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